Research Focus: Comparing CEO Pay to Total Shareholder Return

A recent study conducted by Equilar explores the link between total shareholder return (TSR) performance and CEO pay among S&P 1500 companies. Based on data pulled from Equilar’s new TSR & CEO Pay Modeler, the study provides a benchmark for companies seeking to understand where they fall in the pay-for-performance landscape.

Changes in CEO pay were evaluated over one year (2008-2009) and three years (2006-2009), the time frames typically examined by proxy-advisory firms when they evaluate CEO pay versus TSR performance for voting purposes. This article focuses on the findings from the one-year analysis.

Key Findings

• There was a fairly even distribution of companies into the four separate quadrants. More than 50 percent of CEOs compared in both the one-year and three-year studies saw an increase in pay.

• Among those companies that had an increase in total CEO compensation over the one-year period, total cash compensation (including base salary and bonus) was the key driver of the increase in total compensation.

• Over the one-year period, Retail companies were over-represented among companies that had an increase in CEO pay and above-median TSR.

In the Lexicon

“Pay for performance” is a commonly used phrase in today’s business world—but its definitions vary wildly. In order to determine whether a company is “paying for performance,” several questions should be considered:

• What components of pay are under evaluation: cash pay only (including base salary and bonus), or total compensation, including the value of equity awards, perquisites, etc.?

• What is meant by “performance”? Is it referring to individual performance, company performance, or some combination of the two? If company performance is the focus, which performance measures
should be used in the evaluation—share-price measures, operational measures, or others?

One common definition of pay for performance is that of Institutional Shareholder Services (ISS), a proxy-advisory firm.

ISS evaluates “the alignment of the CEO’s pay with performance over time, focusing particularly on companies that have underperformed their peers over a sustained period. From a shareholders’ perspective, performance is predominantly gauged by the company’s stock performance over time. Even when financial or operational measures are utilized in incentive awards, the achievement related to these measures should ultimately translate into superior shareholder returns in the long term.”

With advisory firms and regulators increasingly focusing on these two metrics, companies must continue to stay on top of how their CEO’s pay aligns with the company’s performance. Equilar’s new TSR & CEO Pay Modeler is designed to help companies see this data the way proxy-advisory firms do, heading off potential PR issues before they occur.

The Methodology

In order to explore the relationship between TSR performance and CEO compensation among U.S. companies, Equilar examined changes in CEO compensation at S&P 1500 companies. For the purpose of this analysis, total compensation is comprised of base salary, annual and long-term cash bonus payouts, the grant-date value of stock and option awards made during the year, changes in pension and deferred-compensation earnings, and all other compensation.

Changes in pay were evaluated over one- and three-year periods, the time frames which are typically the focus of proxy-advisory firms when they evaluate “pay for performance” for voting purposes. The one-year period assessed for this study was 2008-2009, the most recent period for which authoritative data was available.

In order to focus on changes in CEO compensation that were the result of plan design and its link to firm performance, companies that underwent a change of CEO during the time period being evaluated were excluded from the study. Given the volatile market conditions over the past several years, TSR performance among all of the companies in the S&P 1500 has changed dramatically from year to year.

Specifically, the median three-year TSR among S&P 1500 companies was 1.9 percent, the median two-year TSR was negative 4.6 percent, and the median one-year TSR was 25.9 percent. Therefore, in our analysis, below-median one-year TSR performance was considered to be below 25 percent.

Changes in CEO Pay Levels

Among the 1,352 companies studied in the analysis of changes in total CEO compensation over the one-year period, 715 companies, or 52.9 percent, had an increase in total CEO compensation. 631 companies, or 46.7 percent, saw a decrease in total CEO compensation. Six companies had no change in CEO pay over the one-year period.

TSR Performance

Among the 715 companies that had an increase in total CEO compensation over the one-year period, 18.5 percent had a negative one-year TSR and 81.5 percent had a positive one-year TSR.

Among the 631 companies that had a decrease in total CEO compensation over the one-year period studied, 21.6 percent had negative one-year TSR and 78.4 percent had positive one-year TSR. However, since the median one-year TSR among S&P 1500 companies was 25.9 percent, a 25-percent cutoff was used for this analysis.

The accompanying diagram shows how many companies fell into each of the categories for the one-year timeframe. It is notable that the companies are relatively evenly distributed across the four categories. The largest percentage, 29.0 percent, of CEOs fell into the category of receiving increases in their pay while their company experienced an above-median increase in their TSR.

The second-most-populated quadrant contained companies with decreases in CEO pay and below-median TSR, with 24.4 percent of the group fitting into that category. Interestingly, CEOs that received pay increases but saw TSR fall below the median came in third, with 23.9 percent. The diagram excludes six companies that did not have a change in CEO pay over the one-year period.

The companies that saw a change in CEO compensation over the one-year timeframe were studied to determine if certain industries were over-represented in a quadrant, as compared to their representation in the S&P 1500 index.

As shown in the accompanying tables, companies within the Banking and Utilities industries were over-represented in Quadrant 2, meaning those companies that exhibited an increase in CEO pay and below-median TSR, compared to peer companies within the S&P 1500.

Retail companies were over-represented in Quadrant 1, consisting of those companies which had an increase in CEO pay and above-median TSR. Insurance and Capital Goods companies were over-represented in Quadrant 3 (i.e., those companies which had a decrease in compensation and below-median TSR).

The Consumer Durables & Apparel and the Technology, Hardware, & Equipment industries were over-represented in Quadrant 4, the subset of companies within the S&P 1500 that exhibited above-median TSR and a decrease in compensation. For the companies in Quadrants 1 and 2 (i.e., those companies that had an increase in total CEO compensation over the one year period), total cash compensation (including base salary and bonus) was the key driver of the increase in total compensation.

Therefore, it appears that increases in total compensation were the result of incentive-plan design and strategic compensation decisions, rather than merely an increase in the value of equity awards over the course of the year.

Want to learn more? See the full report by visiting www.equilar.com, calling (650) 286-4512, or e-mailing info@equilar.com.

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